First time picking 401k funds

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First time picking 401k funds

Postby shaydwyrm » Tue Feb 05, 2013 11:03 pm

Hi! I have just started to think about retirement savings, after several years of intermittent post-college work during which I wasn't able to put anything away. I am looking for some advice on picking funds in my company 401k.

Age: 28
Income: 80k gross
Emergency funds: 3 months + monthly contributions
Debt: none
Tax filing status: single
Tax brackets: 5.3% state, 25% federal
State of residence: MA
Desired AA: 85/15
Desired International Allocation: 40% of stocks
Asset allocation is based on the idea that I am starting a little late, but I don't plan to touch these funds for a good 30 years, so I would like to aim for more aggressive growth. Also, the plan advisor told me bonds are not expected to do well in the near future.

Size of portfolio: ~10k (just getting started!)


Current retirement assets and future contributions

Vanguard Roth IRA - $5500/yr
47% Vanguard Target Retirement 2050 Fund

401k - $17500/yr
53% American Century LIVESTRONG 2050 Portfolio - Class R

There is no company match for the 401k yet...this may change once we become profitable in the next year or two! (knock on wood)


Available 401k funds: Name (Net ER)

SSgA Cash Series U.S. Government Fund - Class L (0.75)
PIMCO Low Duration Fund - Class R (1.05)
PIMCO Total Return Fund - Class R (1.10)
Prudential High Yield Fund - Class R (1.12)
PIMCO Real Return Fund - Class R (1.10)
American Century LIVESTRONG Income Portfolio - Class R (1.27)
American Century LIVESTRONG 2015 Portfolio - Class R (1.30)
American Century LIVESTRONG 2020 Portfolio - Class R (1.33)
American Century LIVESTRONG 2025 Portfolio - Class R (1.36)
American Century LIVESTRONG 2030 Portfolio - Class R (1.38)
American Century LIVESTRONG 2035 Portfolio - Class R (1.41)
American Century LIVESTRONG 2040 Portfolio - Class R (1.45)
American Century LIVESTRONG 2045 Portfolio - Class R (1.48)
American Century LIVESTRONG 2050 Portfolio - Class R (1.50)
American Century LIVESTRONG 2055 Portfolio - Class R (1.51)
Janus Balanced Fund - Class R (1.34)
BlackRock Equity Dividend Fund - Class R (1.32)
Lord Abbett Fundamental Equity Fund - Class R3 (1.24)
Alger Capital Appreciation Institutional Fund - Class R (1.68)
Perkins Mid Cap Value Fund - Class R (1.34)
American Century Heritage Fund - Class R (1.51)
Fidelity Advisor Small Cap Fund - Class T (1.51)
Goldman Sachs Small Cap Value Fund - Class R (1.61)
Lord Abbett Developing Growth Fund - Class R3 (1.27)
Templeton Foreign Fund - Class R (1.46)
MFS Research International Fund - Class R2 (1.47)
Thornburg International Value Fund - Class R3 (1.45)
Oppenheimer Developing Markets Fund - Class N (1.70)
Fidelity Advisor Real Estate Fund - Class T (1.43)

Questions:

1. After reading around on Bogleheads, these 401k funds seem like their fees are a bit higher than necessary. I've asked the fund administrator if it's possible to add stock and bond index funds to the plan, but there are no guarantees as to whether this will happen, or when. With that in mind, is it still worth investing in the 401k as opposed to a taxable account where I would be able to get better expense ratios?

2. What are the better funds to pick among those available in the 401k to achieve my target AA? Does it make sense to stay invested in the 2050 target retirement fund and balance out my AA using the Roth, or can I do better with the available funds?

I know the portfolio is small, so I am mainly looking for advice on how to allocate new investments going forward.
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Re: First time picking 401k funds

Postby Mill » Tue Feb 05, 2013 11:38 pm

Sheesh, that 401(k) is a serious rip-off. 75 basis points to hold cash!? And its not even matched by your employer. I hate missing out on tax-advantaged space, but these fund choices are just bad.

Personally if I had those choices in my 401(k) and I chose to invest in it, (which is a tough call) I think I might go to bed angry every once in awhile. I just hate getting ripped off. :annoyed
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Re: First time picking 401k funds

Postby LadyGeek » Tue Feb 05, 2013 11:54 pm

Welcome! In spite of those somewhat high fund expenses, the single most important thing you can do here is to start saving. Asset allocation and expenses are secondary.

American Century LIVESTRONG 2050 R Report (ARFWX) has the asset allocation which matches your stated risk tolerance (about 85/15). Since you don't have much of a selection (nothing stands out here that would improve things), you might want to stick with a balanced fund. There's really nothing wrong with them, and they're easy to maintain - nothing to do.
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Re: First time picking 401k funds

Postby LFKB » Wed Feb 06, 2013 12:01 am

If I were you, I would continue to invest in your Roth and then invest the rest in taxable and ignore the 401k until your company implements matching or lower expense ratios are offered.

Without a match, there isn't really a huge advantage to 401k. Sure you can defer your taxes, but it feels like tax rates are only going to go up. If you think you're going to be in a much lower income bracket in retirement then you may want to invest in the 401k though, Also, if you're doing taxable you need to make sure you think of it as a retirement account and don't touch it.

Curious to see what other posters say on this one. It's probably worth it to type the numbers into excel and see what the results are based on various returns (less the expense ratio), withdrawal rates in retirement and estimated tax rates to get a better idea.
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Re: First time picking 401k funds

Postby justus » Wed Feb 06, 2013 3:09 am

LFKB wrote:If I were you, I would continue to invest in your Roth and then invest the rest in taxable and ignore the 401k until your company implements matching or lower expense ratios are offered.

Without a match, there isn't really a huge advantage to 401k. Sure you can defer your taxes, but it feels like tax rates are only going to go up. If you think you're going to be in a much lower income bracket in retirement then you may want to invest in the 401k though, Also, if you're doing taxable you need to make sure you think of it as a retirement account and don't touch it.


I disagree that placing the funds in taxable preferred to placing funds in the 401k. Even if tax rates go up later, that doesn't mean that you'll be paying that higher rate when you withdraw the funds. At some point, you may wish to change jobs and you'll be able to roll the funds you've saved in the 401k into an IRA and have a wider selection of funds. If you miss out on the opportunity to place funds in a tax advantaged account, that opportunity is lost forever.
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Re: First time picking 401k funds

Postby pingo » Wed Feb 06, 2013 3:28 am

I agree 100% with LadyGeek and Justus.

Other reasons the save in the 401k:
-Even though we don't like those expense ratios, there are far worse plans where it is still advisable to save within those plans for the tax advantage.
-The employer may add index funds at his/her request or if s/he campaigns for a better 401k.
-The employer could change plan providers, allowing him/her to roll the former 401k assets into the new plan (if it's good) or to an IRA, where the advantage of tax-deferral would combine with greater flexibility and much lower costs.
-S/he might change jobs and could do as above (already mentioned by Justus).

Given the state of the employer plan and Roth, there is zero advantage to using individual asset class funds, which (in my opinion) also trumps the 40% desired International allocation as well.

Keep all your investment money in a single Vanguard Target Retirement Fund (Roth) and a single AmerCent LiveStrong Fund (401k), forget about it and enjoy life!

:beer
Last edited by pingo on Sun Feb 10, 2013 8:40 am, edited 2 times in total.
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Re: First time picking 401k funds

Postby LFKB » Wed Feb 06, 2013 4:12 am

justus wrote:
LFKB wrote:If I were you, I would continue to invest in your Roth and then invest the rest in taxable and ignore the 401k until your company implements matching or lower expense ratios are offered.

Without a match, there isn't really a huge advantage to 401k. Sure you can defer your taxes, but it feels like tax rates are only going to go up. If you think you're going to be in a much lower income bracket in retirement then you may want to invest in the 401k though, Also, if you're doing taxable you need to make sure you think of it as a retirement account and don't touch it.


I disagree that placing the funds in taxable preferred to placing funds in the 401k. Even if tax rates go up later, that doesn't mean that you'll be paying that higher rate when you withdraw the funds. At some point, you may wish to change jobs and you'll be able to roll the funds you've saved in the 401k into an IRA and have a wider selection of funds. If you miss out on the opportunity to place funds in a tax advantaged account, that opportunity is lost forever.


I was thinking of the compound impact of those expense ratios over 30 years, but if the OP thinks he will likely change jobs or new funds will be offered in the near term, then the impact is not nearly as large and 401k may be preferable. However, if he plans on being at this job for the long term and he think his withdrawal rate in retirement may be similar to his income level today, then taxable could potentially be preferable. As I mentioned, he should come up with some simple assumptions and test it in excel.
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Re: First time picking 401k funds

Postby NYBoglehead » Wed Feb 06, 2013 8:52 am

I'd keep contributing to the 401k and become an absolute pain in the butt about how the funds stink. Make a chart on excel showing how much money that 1.5% ER fund will drain from your returns over 30 years and give a copy to every person at your office. Get everyone to lobby for a better plan - it can be done.

I still think the tax-advantage is worth it even with crappy funds, and if you aren't planning on staying there forever you can do a rollover IRA into Vanguard and pay 18 basis points for their Target Retirement funds.
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Re: First time picking 401k funds

Postby Khanmots » Wed Feb 06, 2013 9:50 am

LadyGeek wrote:Welcome! In spite of those somewhat high fund expenses, the single most important thing you can do here is to start saving. Asset allocation and expenses are secondary.

American Century LIVESTRONG 2050 R Report (ARFWX) has the asset allocation which matches your stated risk tolerance (about 85/15). Since you don't have much of a selection (nothing stands out here that would improve things), you might want to stick with a balanced fund. There's really nothing wrong with them, and they're easy to maintain - nothing to do.


I'd start out with the target date fund, but I'd probably break it up after I'd had a few years to accumulate assets into components as it appears that the ERs for the parts are less than for the whole. It'd also make it easier to maintain an asset allocation (AA) across various accounts (i.e., Roth).

But hopefully in a few years you'll have better choices available and this will all be a moot point.
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Re: First time picking 401k funds

Postby webslinger » Wed Feb 06, 2013 3:15 pm

I am quite impressed with the amount of your salary that you are targeting for savings. As Lady Geek stated, the most important decision (and action) you can take is to save consistently.

Yes, you are looking at high ER for the 401K funds available to you today. But don't forget that you will be investing the $17.5K before taxes. Just a straight back of the envelope tax collection says that this is $4,250 in your pocket based on being in the 25% tax bracket. You should play around with online tax calculators or tax software to see the actual numbers for your situation. This "extra cash flow" may make it easier for you to stick to the savings plan you outlined.

Chances are that in the future you may change jobs or your company plan may improve. At that time you can move to lower ER funds.

One of the big things I learned from this site is the value of simplicity. You have excellent advice from several posters to select the 2050 "all in one" fund.

Best of luck and congratulations,

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Re: First time picking 401k funds

Postby shaydwyrm » Wed Feb 06, 2013 4:06 pm

Thanks for all your responses! It seems like I am on the right track as far as making do with what is available in the 401k. I will continue to contribute to it and continue to push for some better fund choices. As a pretty junior employee there's a limit to how noisy I'm willing to be by myself, but hopefully I can get some other people on my side.

Looking independently at some of the prospectuses for these plan funds, it seems like the plan may be tacking on as much as 0.5% to some expense ratios. Is that par for the course for 401k plans? I can only hope that a passively managed index fund will have less of a markup.

LFKB wrote:...he should come up with some simple assumptions and test it in excel.

This is a good idea, but I am a bit fuzzy on how to compute growth of a taxable account when taking things like taxes on capital gains and dividends into account. It seems much less straightforward than for a tax-deferred account. Are there any good references or forum threads that discuss how to do this kind of estimate? I've taken a couple stabs at it, and if I assume the taxable account has a 0.2% ER vs 1.5% for the taxable account, the tax-deferred account only seems to come out ahead when my tax rate is substantially lower in retirement. However, I am only looking at the growth of a single contribution - would the picture change substantially if I try to model monthly contributions?

LadyGeek wrote:Welcome!

Thanks! I'm very glad to have found this site...a lot of these investment issues were a total mystery to me as little as a month ago.

webslinger wrote:I am quite impressed with the amount of your salary that you are targeting for savings. As Lady Geek stated, the most important decision (and action) you can take is to save consistently.


Thanks! Yes, at present my living expenses are very low thanks to adapting to almost no income for several years, so I am trying to put away as much as possible before I get used to having money 8-)

webslinger wrote:Yes, you are looking at high ER for the 401K funds available to you today. But don't forget that you will be investing the $17.5K before taxes. Just a straight back of the envelope tax collection says that this is $4,250 in your pocket based on being in the 25% tax bracket. You should play around with online tax calculators or tax software to see the actual numbers for your situation. This "extra cash flow" may make it easier for you to stick to the savings plan you outlined.


I have some trouble getting my head around calculations like this. I have an extra $4,250 in my pocket if I compare contributing $17,500 to the 401k vs $17,500 to a taxable account, but if I compare contributing $13k to a taxable account vs $17,500 to the 401k, and then try to adjust the 401k assets for future income tax, the picture starts to get hazy. Then throw in the difference in expense ratio I could get with more flexible fund options, and in many cases it starts to seem like a wash....

justus wrote:If you miss out on the opportunity to place funds in a tax advantaged account, that opportunity is lost forever.


I like this argument - it's very clear and unambiguous :beer
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Re: First time picking 401k funds

Postby Khanmots » Wed Feb 06, 2013 5:23 pm

Given what all has been said, I'd say that since you say it looks to be a wash (or close to) between the 401k and taxable given your assumption that you make your career at this location and no changes are made to the plan... (tell me if I'm wrong on my summary of your analysis!)

I'd be investing in the 401k as not contributing in a year means you've lost that year's space forever and there are a lot of probable ways that the situation could improve to be better than a wash and few relatively improbable ways it could become worse.

If the plan starts offering passive indexed options you're probably ahead.
If the company changes plan providers to a lower cost one, you're probably ahead.
If you can play the tax game right in retirement to stay in a low(er?) tax bracket you're probably ahead.
If the company starts offering a company match you might come out ahead.
If you switch companies at some point in your career you're probably way ahead.

If they change to an even more expensive plan provider to save costs you might come out behind.
If you're in a higher tax bracket in retirement than you are today you'll probably be behind.

Just something to think about while you work to get a better plan in place. Good luck!
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Re: First time picking 401k funds

Postby hoppy08520 » Wed Feb 06, 2013 6:24 pm

shaydwyrm wrote:
justus wrote:If you miss out on the opportunity to place funds in a tax advantaged account, that opportunity is lost forever.

I like this argument - it's very clear and unambiguous :beer

This is a line I've used a lot too. Every year, you get to shelter "only" $23,000 from tax ($17,500 for the 401(k) + $5,500 for the IRA), and some people have other opportunities as well (457, HSA, FSA, 529, after-tax 401(k) contributions, etc.).

You don't get those opportunities back. Once that year is gone, you can't go back in time and put $23,000 into tax year 2010, for example.

I feel like a lot of people get emotional/angry about expensive 401(k) plans and there can be a tendency to say, "I'm not giving those thieving companies a dollar of my money!" I understand that sentiment and I myself foolishly did that for some years. I maxed my IRAs and contributed up to the point where I got the maximum 401(k) match, but not much beyond that because I didn't like the 401(k) plan. In retrospect, I wish I had contributed more to the 401(k) plan in spite of the fees, yet now "that opportunity is lost forever".
:oops:
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Re: First time picking 401k funds

Postby Jeff7 » Wed Feb 06, 2013 8:11 pm

NYBoglehead wrote:I'd keep contributing to the 401k and become an absolute pain in the butt about how the funds stink. Make a chart on excel showing how much money that 1.5% ER fund will drain from your returns over 30 years and give a copy to every person at your office. Get everyone to lobby for a better plan - it can be done.

I still think the tax-advantage is worth it even with crappy funds, and if you aren't planning on staying there forever you can do a rollover IRA into Vanguard and pay 18 basis points for their Target Retirement funds.

And hope that the plan administrator isn't a "trusted friend" of the company's owner.
Math and numerous studies of data from the entire history of mutual funds can be useless against something like that. :(



Mill wrote:Sheesh, that 401(k) is a serious rip-off. 75 basis points to hold cash!? And its not even matched by your employer. I hate missing out on tax-advantaged space, but these fund choices are just bad.

Personally if I had those choices in my 401(k) and I chose to invest in it, (which is a tough call) I think I might go to bed angry every once in awhile. I just hate getting ripped off. :annoyed

Yes indeed. (Is that subtly showing through yet? :? )
I'd rather be saving for my retirement, and less for the plan administrator's (early) retirement.


hoppy08520 wrote:...
I feel like a lot of people get emotional/angry about expensive 401(k) plans and there can be a tendency to say, "I'm not giving those thieving companies a dollar of my money!" I understand that sentiment and I myself foolishly did that for some years. I maxed my IRAs and contributed up to the point where I got the maximum 401(k) match, but not much beyond that because I didn't like the 401(k) plan. In retrospect, I wish I had contributed more to the 401(k) plan in spite of the fees, yet now "that opportunity is lost forever".
:oops:

I, too, took awhile to start pushing more into my 401k, past the company match, for that reason. It particularly bugged me when the plan administrator told me that the 0.75% 12b-1 fee would go down to 0.50% if everyone got their contributions up over a certain level. So the solution to "Your prices are too high" was "Give me more money." :|
But, I did do it in time, for that reason: That snippet of tax-advantaged space is fleeting.
I'm now up to putting a total of about 20% of my gross pay into stock and bond investments through a Roth IRA and the 401k. Still nowhere close to maxing out the 401k though.
They wouldn't offer a brokerage window either.
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Re: First time picking 401k funds

Postby pingo » Thu Feb 07, 2013 7:18 pm

LFKB wrote:I was thinking of the compound impact of those expense ratios over 30 years [...]


Yeah, it's huge. We often speak of the impact of costs within the range we're talking about here, but we tend to speak of the impact versus a lower cost option in the same tax circumstances (all else being equal). So, yeah, a fund with ER 1.5% will likely underperform a comparable index version with ER 0.15% by 20-30% over a few decades*, but after taxes the 1.5% fund probably wins because it's in the 401k to avoid losing a major chunk of investible cash. So, in this case, a low cost index fund in a taxable account is probably not an improvement over tax-deferred savings at ER 1.5%.

In my view, the OP comes out ahead with the tax savings versus paying high taxes now in order to get to lower expense ratios. (Taxes are costs, too.) If OP's funds were 3+% and or had heavy sales charges, I think the scales begin tipping in favor of taxable investing instead.

(*I pulled this number out of the air based on a loose memory things I've read. I did not consult Common Sense on Mutual Funds or anything of the sort.)
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Re: First time picking 401k funds

Postby shaydwyrm » Fri Feb 08, 2013 12:28 pm

pingo wrote:
LFKB wrote:I was thinking of the compound impact of those expense ratios over 30 years [...]


Yeah, it's huge. We often speak of the impact of costs within the range we're talking about here, but we tend to speak of the impact versus a lower cost option in the same tax circumstances (all else being equal). So, yeah, a fund with ER 1.5% will likely underperform a comparable index version with ER 0.15% by 20-30% over a few decades*, but after taxes the 1.5% fund probably wins because it's in the 401k to avoid losing a major chunk of investible cash. So, in this case, a low cost index fund in a taxable account is probably not an improvement over tax-deferred savings at ER 1.5%.

In my view, the OP comes out ahead with the tax savings versus paying high taxes now in order to get to lower expense ratios. (Taxes are costs, too.) If OP's funds were 3+% and or had heavy sales charges, I think the scales begin tipping in favor of taxable investing instead.

(*I pulled this number out of the air based on a loose memory things I've read. I did not consult Common Sense on Mutual Funds or anything of the sort.)


One of the things I noticed when playing with these spreadsheets was that lower market returns tip the scales in favor of the taxable account. This is because the taxable account loses a percentage of earnings, but the expense ratio takes a percentage of assets. For example, if the market only gains 1% for one year, a 1.5% ER fund would actually lose money, whereas the taxable account would still make some earnings.
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Re: First time picking 401k funds

Postby hoppy08520 » Fri Feb 08, 2013 12:32 pm

If it helps, the wiki has some information on break-even considerations of investing in a bad 401(k) versus taxable investing, including links to articles and spreadsheets:

401(k) at Bogleheads wiki
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Re: First time picking 401k funds

Postby pingo » Fri Feb 08, 2013 5:50 pm

^Nice. Thank you, hoppy!

shaydwyrm wrote:One of the things I noticed when playing with these spreadsheets was that lower market returns tip the scales in favor of the taxable account. This is because the taxable account loses a percentage of earnings, but the expense ratio takes a percentage of assets. For example, if the market only gains 1% for one year, a 1.5% ER fund would actually lose money, whereas the taxable account would still make some earnings.


Excellent point! :beer
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Re: First time picking 401k funds

Postby shaydwyrm » Sat Feb 09, 2013 2:08 am

hoppy08520 wrote:If it helps, the wiki has some information on break-even considerations of investing in a bad 401(k) versus taxable investing, including links to articles and spreadsheets:

401(k) at Bogleheads wiki

Oh, I even read that page, but I wasn't looking for that information at the time :oops:

Thanks, that's a nice heuristic!
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